Market Failure

What is the meaning and significance of market failure? Is it sufficient to justify public sector intervention?

Adam Smith despite his theory of laissez faire economics, where allocative efficiency is achieved only through the free market, have identified that there are some very significant areas in the supply of goods and services which cannot be satisfactorily met by the market economy without some form of government assistance[1]. Modern economists describe the tendency of the market to fall short in this respect as “market failure”. Standard economic theory identifies several major ways in which the market economy cannot adequately provide for. The most well-known of those issues are imperfect competition, imperfect information, public goods and merit goods, externalities, natural monopolies, monopsonistic markets and macro-economic policy[2]. This paper serves to discuss each of these different types of market failure and explain why each case offers a satisfactory argument to substantiate public sector intervention.

Firstly, if left to each own devices, the functions of the market cannot put a stop to the problem of imperfect competition[3]. This refers to collusive practices and anti-competitive behavior when two or three firms agree to set a same price for a particular good or service. Similarly, imperfect competition occurs when there is an imbalance of power in market such as domination in the market by only one firm (monopoly). Competition is the essence of the market thus to reduce the firms’ pressure to compete in one way or another is a threat to the market[4]. When this turns out, the market for that particular good or service is ruined. Instead of firms competing with one another which would eventually lead to goods being sold at the best lowest possible price, firms enjoy the benefit of making extra profit at its customers’ expense[5] . Although it is regarded as illegal in many countries, it is prevalent that firms and businesses do involve...